A Guide to Choosing the Best Personal Loan for You
Personal loans present a flexible funding option for almost any use. This guide describes how to select the best personal loan for you.
August 3, 2022
Whether you need funds to cover an upcoming renovation or you’re looking to consolidate existing debt, personal loans may be an option. These loans provide a flexible solution to cover just about any expense — although they can come with high-interest rates.
In this guide, we’ll cover:
How personal loans work
How to go about finding the best personal loans for any given situation
What is a personal loan?
Personal loans are a type of loan product offered by banks, credit unions and online lenders. They offer a fixed loan amount, paid back over a set period in equal monthly installments.
For example, a borrower may take out a $5,000 personal loan with a 5-year repayment period. They would have monthly payments of around $100 to $130, depending on the interest rate. After 5 years, the loan would be paid off.
The benefits of a personal loan include high loan limits, flexibility in how the funds are used and interest rates that are generally lower than credit cards.
A personal loan often transfers funds directly to the borrower’s bank account. Personal loans can be used for nearly any purpose — making a major purchase, consolidating debt, paying for home renovations or simply covering day-to-day expenses.
Personal loans are often available for between $5,000 and $50, and select lenders offer small personal loans for as low as $1,000. Personal loans are relatively common, making up around 1% of total consumer debt in the U.S. (compared to 6% for credit cards). The average personal loan balance is $6,656.
What’s the average personal loan APR?
Overall, interest rates on personal loans range from 4.49% to 36%. The average personal loan rate ranges from around 10.3% for borrowers with good or excellent credit with substantially higher rates for borrowers with lower credit scores.
Personal loan APRs (annual percentage rate) vary depending on the borrower’s creditworthiness. The factors that influence the interest rate on a personal loan include:
The borrower’s credit score
The borrower’s income
The borrower’s debt-to-income ratio
The size of the loan
The length of the loan
The issuing lender
The best personal loan APRs tend to go to borrowers with excellent credit, high income and reliable credit history. On the other hand, borrowers with poor credit may receive very high personal loan interest rates — or may not qualify.
Because rates vary dramatically, the only accurate way to determine your potential personal loan, APR, is to check with a lender or use an online pre-qualifying tool.
How to prepare for a personal loan
Here’s what to consider before applying for a personal loan.
Consider your alternatives
Depending on the circumstances, personal loan alternatives may be worth considering.
For example, if you own your home, a home equity line of credit (HELOC) may offer a better interest rate than a personal loan if you own your home. Or if you already have a personal line of credit, you might be able to utilize that instead of applying for a new loan.
If you have an emergency fund, you may be able to dip into savings to avoid taking out any sort of loan. Or you may be able to get a loan from friends or family to cover the expense.
Check your credit score
Knowing your credit score is an important first step before applying for any loan. You can check your score using a free tool like Credit Sesame or Credit Karma or request your free full credit report annually at annualcreditreport.com.
The minimum credit score for a personal loan varies depending on the lender — but it’s typically between 540 and 620. If your credit score is lower than you would like, you can learn about the various factors that influence credit scores to determine how to improve yours.
Prepare your budget for monthly payments
Before taking out a loan, it’s important to know that you can afford the required monthly payments. If you currently budget, determine how your monthly payments might fit in. And if you’re not yet budgeting, now is a great time to start.
You can estimate your monthly payment amount by using a personal loan calculator.
How to find the best personal loan for you
Here’s what to consider when shopping around for a personal loan:
The interest rate offered will have the biggest impact on your monthly payment and your total interest costs over the life of the loan. It’s helpful to check with multiple lenders to see which can offer the best interest rate.
Some borrowers may prefer to borrow from a bank where they already have an account. This can simplify the process — but it’s often not worth the trade-off if better interest rates are available from another lender.
Each lender will have different requirements for approval. Some lenders list their minimum requirements (including minimum credit score), but most require you to apply directly. You can contact the lender if you have questions before applying.
Each lender has different minimum and maximum loan amounts. Minimums are often in the $3,000 to $5,000 range, while maximums vary from $30,000 to $100,000 or more (depending on creditworthiness and income).
Personal loan terms usually range from 2 to 5 years. The shorter the repayment term, the higher your monthly payments will be. Before applying, compare your estimated monthly payments to your budget to ensure that you can afford the payments.
How to get a personal loan
Here are the basic steps to applying for a personal loan:
Determine how much you need to borrow.
Get prequalified using an aggregator such as Bankrate. This lets you see estimated rates and terms from many different lenders simultaneously.
Compare rates and terms to find the right fit for your needs.
Complete the application process.
If approved, funds will be available to you shortly and will generally be transferred directly to your bank account. If your application is denied, you may need to improve your credit score before applying again.
Managing your personal loan
Once approved, the funds from your loan will be deposited into your bank account. From there, it’s up to you to determine how you want to use the money.
Monthly payments on personal loans typically start immediately — your first payment will likely be due within a month of being issued. The lender will provide you with a statement and payment due date.
It’s wise to set up automatic payments to ensure you never miss a required payment. Missed payments can lead to late fees and negative marks on your credit score.
Personal loans offer benefits for well-qualified borrowers, but it’s important to consider all your options. By comparing offers from multiple lenders, you can ensure that you find the right fit for your needs.
Are you considering using a personal loan to consolidate credit card debt? Tally† may be an alternative to consider. Tally helps qualifying applicants consolidate credit card balances into a lower interest line of credit. Learn how Tally works here.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.